Fannie and Freddie can’t keep up the PACE

The current administration has implemented a new program to help homeowners install energy improvements and then pay them back over time. $150 million of stimulus money has been devoted to the program, known as Property Assessed Clean Energy (PACE). PACE allows for local governments to borrow by issuing bonds and using the funds to lend homeowners money to cover the costs of installing energy improvements.

The PACE funds lent to the homeowner become a lien on the homeowner’s property as an improvement bond assessment, junior to property taxes but senior to the lender’s trust deed mortgage on the property. The payments are annual and paid along with the homeowner’s property taxes to the county tax collector.

However, on May 5th,, 2010, Fannie Mae and Freddie Mac released an open lender-guidance letter warning that any improvement bond assessment lien on a home must be cleared before originating a loan on a property. This is so the lender has a first trust deed mortgage on the property which is subject to only current property taxes, CC&Rs, etc.

first tuesday take: Recently, the California Attorney General’s office jumped into the fight, filing a complaint in the U.S. District Court in Oakland. Seeking to set aside Fannie’s lender-guidance letter as a “regulatory strangulation of the state’s grass-roots program,” the Attorney General’s office claimed the bond-and-loan programs were inaccurately labeled as “loans” instead of “assessments.”

California has a high stake in this debate, as the state could lose up to $100 million in federal stimulus money. San Diego’s PACE program is currently on hold, leaving more than 100 newly-trained workers without jobs and clean energy companies facing layoffs. $450 million in retro-fit projects, PACE-molded state energy efficiency and low-income programs and thousands of local construction jobs are currently waiting in limbo.

The problem here, beyond labels, is that each side is arguing a different concept. PACE supporters are arguing for job creation and clean energy, while lenders are concerned with lien priorities, underwriting guidelines and consumer protection. Further, the assessment bond liens are loans by definition, for which the property owner received nothing directly benefiting him or the property for his payments — the antithesis of property taxes.

The PACE program was not a logically designed effort to finance the costs of energy improvements since the legal ramifications were clearly not considered. This is one of many efforts by the administration to create jobs by extending or creating conditions for credit, most of which have been futile with minimal impact on the recovering economy. While these efforts look good on paper for the administration and the California Attorney General, they serve very little purpose in application.

However, those in real estate sales during the mid-90s are all too aware of the Mello-Roos improvement district assessment bonds and what they did to the lenders that went junior behind them. Also, subdividers who used them found they could not sell their houses for the same amount as comparables across the road. Competing home builders advertised “No Mello Roos” to entice buyers to forego the hassle of Mello-Roos and purchase their lien-free properties.

The lender’s security interest in the property is impaired by the existence of a senior assessment bond lien which financed property improvements — improvements which make up part of the property’s fair market value and is the basis for a lender’s maximum loan-to-value (LTV) calculation.

Owners selling their properties are equally disillusioned to find the prices they paid exceeded the value of the properties since they assumed the costs of the bonded indebtedness on the property.

The upshot was that lenders quickly determined they needed to be insured as holding a first trust deed on the property and any monetary liens other than current taxes had to be cleared from title before they will fund a mortgage. Therefore, the bonded indebtedness must be resolved.

The assessment bond can be paid from the seller’s net proceeds of sale which will deliver title clear of all liens, or the owner can refinance his property can pay the bond. Any monetary lien, including unpaid taxes, reduces the owner’s equity in the property.

Sellers must deliver the title to the buyers “free and clear,” since the buyer’s purchase-assist lender will not accept a second trust deed (the assessment bonds being a first lien foreclosable by a trustee’s sale and thus a trust deed by another name).

The special PACE financing seems like an innovative way to help homeowners fund energy efficient improvements. However, it is strange that the PACE designer didn’t investigate just how lenders would respond. Why didn’t the PACE designers anticipate that lenders will not allow an energy improvement lien to trump their mortgages and, on a default, leave the lender paying the improvement lien?

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